AvalonBay Communities, Inc.

Good morning, ladies and gentlemen, and welcome to the Avalon Bay Community's first quarter 2021 earnings conference call. At this time, all participants are in a listen-only mode. Following remarks by the company, we will conduct a question and answer session. You may enter the question and answer session queue at any time during this call by pressing star 1. If your question has been answered or you wish to remove yourself from the queue, press star 2. If you are using a speakerphone, please lift the handset before asking your question and we ask that you refrain from typing and have your cell phones turned off during the question and answer session. Your host for today's conference call is Mr. Jason Riley, Vice President of Investor Relations. Mr. Riley, you may begin your conference.

Thank you, Anna, and welcome to Avalon Bay Community's first quarter 2021 earnings conference call. Before we begin, please note that forward-looking statements may be made during this discussion. There are a variety of risks and uncertainties associated with forward-looking statements, and actual results may differ materially. There is a discussion of these risks and uncertainties in yesterday afternoon's press release, as well as in the company's Form 10-K and Form 10-Q filed with the SEC. As usual, this press release does include an attachment with definitions and reconciliations of non-GAAP financial measures and other terms, which may be used in today's discussions. The attachment is also available on our website at www.avalonbay.com forward slash earnings, and we encourage you to refer to this information during the review of our operating results and financial performance. And with that, I'll turn the call over to Tim Naughton, Chair and CEO of Avalon Bay Communities, for his remarks. Tim? Okay, great.

Thanks, Jason, and welcome to our Q1 call. With me today are Ben Shaw, Kevin O'Shea, Matt Bierenbaum, and Sean Breslin. Ben, Sean, and I will provide comments on the slides that we posted last night, and all of us will be available for Q&A afterward. For our prepared comments today, I'll start by providing an overview of Q1 results. Sean will elaborate on operating trends in the portfolio, where fundamentals have improved materially since the beginning of the year, and we'll also review our Q2 outlook. And then Ben will provide some thoughts as to why we believe we are positioned for outsized growth as the recovery and expansion take hold. Now let's turn to the results for the quarter, starting on slide four. In terms of operating results, it was another tough quarter. Core FFO growth was down by over 18% at Q1. Same-store revenue declined by 9.1% on a year-over-year basis. Given the timing of the pandemic, which began toward the end of Q1-20, this past quarter will be the toughest year of your comp will face this year. On a sequential basis, the decline in same-store revenue leveled off at 1.5% from Q4, which compares to a sequential decline of 1.6% in Q4-20. And Sean will touch more on the sequential trends in his comments. And then lastly, we completed almost $600 million of development in Q1 at a projected initial yield of 5.6%, well above prevailing cap rates we're seeing in the transaction markets, where cap rates are drifting down to or below 4%. Given the improvement that we've seen in fundamentals, we're ramping up the development pipeline and expect to start $650 million this quarter, Q2. with much of that to be match-funded with expected dispositions of approximately $500 million in the second quarter. Turning now to slide five, as we did last quarter, we thought we'd provide a little more detail on the components of the decline in same-store revenue that we've experienced on a year-over-year and a sequential basis. Starting on slide five, on a year-over-year basis, This past quarter, about two-thirds of the decline in same-store revenue was a result of lower effective rents, driven by a combination of lower lease rents and higher concessions than we saw in Q1 of last year. The rest of the decline was mostly a function of elevated bad debt, as uncollectible revenue was just over 3%, or roughly 230 basis points higher than last year. The impact of bad debt on a year-over-year same-store revenue basis will be much less over the balance of the year as bad debt initially spiked in Q2 of last year at the onset of the pandemic. Turning to slide six, sequential same-store revenue was down 1.5% in Q1 from Q4. As you can see, it was driven mostly, again, by lower effective rents, but partially offset by 120 BIPs improvement in occupancy. Turning to slide seven, we saw meaningful improvement in like-term rent change during the quarter. And continuing into April, with average like-term effective rent improved by 270 basis points versus the Q4 average, and improved another 310 basis points above that in April, versus what we saw in Q1. As you can see in this chart, the pace of improvement has been steady and quite healthy since the beginning of the year. And again, Sean will provide more color on what's driving these trends in his remarks in just a moment. But let me just share one more slide on development performance first before we turn it over to Sean. I'll turn to slide eight. Slide eight shows that despite the many challenges faced by our business over the last year, The lease-up portfolio is actually performing quite well, with average rents, costs, and yields roughly in line with pro forma, and it's delivering meaningful value with yields well above prevailing cap rates. As a result of this performance and improved operating fundamentals, we are reactivating the pipeline and expect to start six communities totaling about $650 million in Q2. So with that, I'll turn it over to Sean to discuss portfolio trends in more detail. Sean?

All right, thanks, Tim. Moving to slide 9, we've seen an acceleration in the trends we spoke about on our last call, with physical occupancy continuing to increase during the quarter, now approaching 96%, and average move-in rent value growing steadily over the last four months. For April, our month-to-date average move-in rent is roughly 5% above what we experienced in January of this year and approximately 8% below the pre-COVID peak rent we achieved in March of 2020. One point to note when looking at the move-in rent value in this slide and the next couple slides is that it reflects leases that were signed roughly four weeks prior to the move-in date, so it does not reflect the asking rent in each period, which was higher and something I'll address in a few slides. Moving to slide 10, improved portfolio performance has been broad-based. with every region experiencing gains in both occupancy and average move-in rent. Southern California is the one region where we're essentially back to pre-COVID occupancy and rent levels, supported by a relatively stable LA market and rapidly improving conditions in Orange County and San Diego. In Northern California, performance has steadily improved the past few months, particularly from an occupancy standpoint, but it suffered the greatest rent decline during 2020, and recent move-ins are still 17% below the pre-COVID peak. The average April move-in rent in our other regions is generally 7% to 8% below the pre-COVID peak, with the exception of Seattle, which is about 11% below its pre-COVID peak rent, but has demonstrated very positive momentum the past couple months. Turning to slide 11 to address suburban and urban performance trends, Our suburban portfolio is essentially a pre-COVID occupancy now, and the month to date average April move-in rent is only 2.5% below the pre-COVID peak we achieved in March 2020. The urban portfolio, however, is still early in its recovery, with expected gains in both occupancy and rent still to come. Occupancy has increased by more than 500 basis points from the 2020 low point, but we'll need to pick up another couple hundred basis points to reach historical norms for stabilized occupancy. Additionally, the average April move-in rent is trending at roughly 18% below the pre-COVID peak rent, driven primarily by New York City, which is about one-third of our New York, New Jersey portfolio, and San Francisco, which represents about a quarter of our Northern California portfolio. the average April move-in rent in each of these two markets was roughly 22% below the pre-COVID peak rent. We expected more rapid recovery in move-in rents over the next couple quarters as people are called back to the office, urban universities announce on-campus learning, and the quality of the environment improves when retail, restaurant, entertainment, and other services reopen for in-person experiences. We're starting to see some of that demand already, which is reflected in our asking rents, and a point I'll touch on in a couple of slides. Moving to slide 12, the improvement in average effective moving rent has resulted from both an increasing average lease rent, as depicted in chart one, and declining concessions, shown in chart two. The percentage of leases with a concession exceeded 50% last fall, but has trended down to less than 25% for April. And as of this week, only 13% of our available inventory includes a concession, which will support continued growth in our average move-in rent value in future periods. Turning to slide 13, our portfolio is well-positioned heading into the prime leasing season. First, as I mentioned earlier, we're in a solid position from an occupancy standpoint at almost 96% today, which provides a solid foundation to push rents and absorb some turnover if needed to achieve those higher rents. Also importantly, our average asking rent has increased about 13% since the trough point last November and roughly 5% in just the past four weeks, which is quite strong and substantially more than historical seasonal norms. Additionally, if you factor in the reduced volume of concessions I mentioned on the last slide, the increase in the average net effective asking rent since the trough point is about 15%. If you look at this relative to our pre-COVID peak rent levels, our current average asking rent is only down about 70 basis points. And if you factor in concessions, net effective asking rents are only about 2% below the pre-COVID peak. Moving to slide 14 to address our second quarter outlook, we expect core FFO per share of $1.90. For same-store performance, the midpoint of our outlook for year-over-year NOI growth is minus 11.5%, driven by a 5.5% reduction in revenue and an 8.25% increase in operating expenses. The relatively substantial operating expense growth rate is primarily driven by a very difficult comp from Q2 2020, when activity, including move-ins and move-outs, maintenance, et cetera, was severely limited, and we constrained spend, including hiring, at the onset of the pandemic as shelter-in-place orders took effect. In terms of the sequential roadmap from Q1 core FFO per share of $1.95 to the Q2 outlook of $1.90, we expect a $0.05 deterioration in same-store NOI, all of which relates to the sequential change in operating expenses, as we expect sequential revenue growth to be zero. We also expect a two cent improvement in commercial and other residential NOI, which will be offset by a two cent increase in overhead and other. Now I'll turn it to Ben to address the outlook for our business over the next few years. Ben?

Thank you, Sean. Supported by this backdrop of improving operating fundamentals, we believe that we are well positioned to generate outsized growth as the economy recharges. As we look to the composition of our existing portfolio, Each of the sub segments highlighted on slide 15 have been impacted in varying degrees during the pandemic and each have their distinct growth opportunities as we look forward. Our largest segment at 40% of revenue is in what we've called out as other suburban to differentiate it from more densely populated job center suburban markets. This 40% of our portfolio was the least impacted by the pandemic and our current asking Our current average asking rent is 6% above the pre-pandemic peak rent we achieved in March of last year. We continue to push asking rents in these submarkets, and concessions have largely been eliminated. Our next largest segment at 28% of the portfolio represents communities and job center suburban markets, including our transit-oriented development, places like Redmond, Washington, Tyson's Corner in Virginia, and Assembly Row in Massachusetts. Operating fundamentals in many of these suburban locations have been more significantly impacted, with asking rent still 3 to 4% below pre-pandemic levels and with the continued use of concessions in certain markets. Our expectation is that as people increasingly return to the office and nearby restaurants and as other amenities start to reopen more fully, we will increasingly see prospects that seek out these environments for walkability, ease of transportation, and the array of services provided. For our communities and urban environments, we have a mix of core urban, effectively central business districts, and secondary urban, locations like Jersey City, New Jersey, and the Roslyn-Boston corridor in Northern Virginia, which make up 19% and 13% of our portfolio, respectively. As Sean noted, occupancy in our urban portfolios climb more than 500 basis points, and rents are trending upward in pretty much all of the urban environments. And this has occurred with urban office usage still at very low levels of less than 20%. As a return to offices starts to gain real momentum this summer and leading up to Labor Day, we do expect a significant rebound in our urban portfolio as in prior cycles. This is a theme that we expect to be true across much of our portfolio. As shown on chart one of slide 16, Class A communities, which represent approximately 70% of our portfolio, have historically outperformed early in cycles. We expect similar trends in this recovery, particularly as the traditional higher-income ABB resident is poised to benefit financially as the economy heats up. And while our residents stand to benefit from the recovery, it is also becoming more challenging for those interested in buying a home to afford one, given the acceleration in home prices in many of our coastal markets. Chart 2 on slide 16 shows this long-term affordability trend and the growing attractiveness of renting versus owning a home in our markets. Turning to slide 17, the development we currently have underway is also poised to deliver strong future earnings growth as these projects are completed and stabilized. In total, we have $2.3 billion of development that has not yet been stabilized and is projected to generate $134 million of NOI at a 5.7% yield. In total, the development communities only contributed $22 million in annualized NOI as of Q1 of this year, so there's another $112 million in annualized NOI still to come. These developments are primarily in our suburban markets, where we expect to see strong fundamentals as these communities open over the next couple of years. And as been our standard practice, this development activity is substantially match-funded, reducing the capital cost risk associated with the earnings and NAV accretion yet to come. As we anticipate a recharging economy, we are adjusting our capital allocation strategy to ramp up new development starts. As Tim noted, we expect to put ground on as many as six new development projects in the second quarter, representing $650 million in new accretive investment, primarily in our suburban submarkets. With a total development rights pipeline of $3.1 billion, we anticipate further increases to our development starts in future quarters, and are increasing our guidance for total 2021 starts from the 750 million we had indicated on our February call to a billion to a billion 250, as we have the ability to move quickly to capitalize on the improved outlook for fundamentals in our markets. As we look forward, we expect the breadth of our development experience, particularly in the suburbs from denser wrap developments to garden communities to townhome and direct entry homes, will allow us to shift capital and adjust our product offering to meet the evolving needs of our targeted customer segments. Switching gears to innovation in our operating business and turning to slide 18, the team here is now about three years into a significant shift in our operating platform, having generated 10 million in annual incremental NOI from our initial initiatives, and with the expectation of another 25 to 35 million of annual NOI from our near-term operating roadmap. One meaningful example of an initiative already deployed is our early adoption of an artificial intelligence for the management of prospective residents. Our AI leasing agent, Sydney, is available 24-7, 365 days a year, and interacts with prospects regarding their questions about our communities, schedules and reschedules tours, follows up post tour, and facilitates the application process. Sydney has sent more than four million messages to prospects that would have been handled by an onsite or call center associate in the past. And in addition, Sydney has scheduled almost 100,000 tours at our communities. We continue to invest in our operating platform and are focused on the use of digital platforms and data science to drive operational efficiencies and optimize revenue from our assets through initiatives such as the search, application, and lease process on our revamped website that we are relaunching later this year. the increased rollout of smart access to allow for more automated and self-serve activities, including full self-touring and public access for revenue opportunities, use of data science to optimize our renewal results, and next steps in mobile maintenance to improve efficiency and service. Collectively, we believe we'll enhance operating margins by about 200 basis points through these various initiatives, while also providing a more seamless, personalized experience at our communities. Finally, as we look forward, we're excited to further advance Avalon Bay's position as a recognized ESG leader among all REITs and within the multifamily sector, as highlighted on slide 19. In addition to setting science-based targets to reduce scope one and scope two emissions by approximately 50% by 2030, we're also one of the first real estate companies to complete an extensive climate resiliency analysis across our portfolio. evaluating each asset across 11 key risk factors. From this analysis, the team is developing asset-specific action plans, and we have also now incorporated the resiliency framework into our go-forward investment and development decisions. We've also established measurable inclusion and diversity goals, focused on achieving gender parity for leadership by 2025 and increasing minority representation and leadership to 20% by 2025 and 25% by 2030. And we're now incorporating these goals into our business unit planning to drive results. What will come later this year is release our fulsome and industry leading corporate responsibility report in June. And as we continue to reinforce ESG as a differentiator in the eyes of our residents, communities, and stakeholders. We're very excited for where we're headed and the growth in front of us. And with that, I'll turn it back over to Tim.

Great. Thanks, Ben. And just turning to the last slide and to summarize some key points for the quarter. Slide 20. Q1 was a challenging quarter in terms of results. But as I mentioned before, it is expected to be the toughest year-over-year revenue comp we see this year. In addition, the recovery in fundamentals is taking hold in our markets, as Sean discussed. Many suburban submarkets are now at or above pre-COVID levels. while the early improvement we're seeing in urban submarkets should gain strength mid-year and into the fall as workers return back to the office. And lastly, as Ben mentioned in his remarks, we believe we are very well positioned over the next few years due to a number of factors, including our coastal market footprint, a portfolio that is heavily concentrated in urban and job center infill suburban markets, excuse me, the rising cost of home ownership, healthy performance and a ramp in our development pipeline, margin improvement in our stabilized portfolio due to innovation in the operating model, and then lastly, a leadership position in ESG where the investment we've made over the last several years is paying off in terms of outback savings and stakeholder engagement. So with that, Operator Anna, we'd be happy to open the call for questions.

Yes, sir. Thank you. And if you would like to ask a question, please signal by pressing star 1 on your telephone keypad. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Once again, that is star 1 if you would like to ask a question. And we'll now take a question from Nick Joseph with Citi.

Thanks. Maybe just starting off with guidance, I was wondering if you could talk through the decision to not issue full-year guidance at this point, just given that we already have 1Q results and the operating trends that you've walked through. What held back that decision to institute 2021 guidance?

Hey, Nick. This is Kevin. Yeah, I mean, as we've indicated before, providing quarterly guidance, you know, which is what we've done this week, this quarter, is consistent with how we have been managing the business. as we move through a pretty dynamic environment in a certain period of time. But given the stability and the growth that we're seeing in April as we head into May, as Sean pointed out, we do expect to be able to provide guidance for the balance of the year in connection with our second quarter call after we've had a chance to complete our customer and media re-forecast, which is a lot more fulsome than the Q1 re-forecast process that we do for this call.

Okay, that's helpful. And then for the $650 million of starts this quarter, what's the expected initial yield on those, and then is that on in-place rents or trended rents?

Hey, Nick, it's Matt. Yeah, those deals, the yield is kind of very consistent with where our current development underway is. It's kind of high fives. And that's pretty much in every case when we quote yields, we're quoting based on today's rents, today's costs. We don't trend it. And, in fact, on our development attachment, we don't mark those rents to current market until we get at least about 20% lease. So that's why we see most of the rents in the attachment are still what we were carrying when we started the job. So my guess is, you know, given where we are today and given the ones we haven't started, At today's market, there's probably a pretty good chance that we'll exceed the underwriting on those by the time they stabilize.

Thank you.

We'll take our next question from Rich Hightower with Evercore.

Hi. Good afternoon, guys. I think Nick took two of my questions, so let me fire a different one at you. But just to follow up on the development question, We probably said the same thing for the last five or ten years, but market cap rates can't go any lower than they are. Tell us how you think about the possibility of market cap rates expanding from here and perhaps that yield differential narrowing as you think about that high five development yield target. How much cushion do you take into the way you think about that?

Rich, Tim here. I mean, as Kevin's mentioned plenty of times in the past, I mean, it is something we take into consideration. It informs how we think about match funding, the development book. And I think we showed this quarter it's largely match funded. And we expect, if we believe that there's capital market risk, that we're going to be closer to 100% match funded, which means essentially the time we start construction is making the big capital commitment. the permanent capital has already been raised, either in the form of equity debt or dispositions.

Okay. That's fine. Thanks. And then just on the expense guidance, I know that we are lapping a TUS comp in 2Q, and there's a little bit of detail in the slide deck on this, but maybe just break down some of the categories where you expect the biggest year-over-year growth in expenses.

Yeah, Rich, this is Sean. I mean, I hate to say it, but it's pretty broad-based. I mean, if you think about what happened in Q2 last year, things really shut down. So turnover declined. We dropped back to strictly essential maintenance only for our resident customers. We pulled back on marketing given sort of the demand shock. You know, we adopted a hiring freeze. So if you think about all the various sort of maintenance activities, payroll, et cetera, We're expecting all of those to look more normal as compared to the depressed levels that we experienced in Q2 of 2020. So it's relatively broad-based. Most of it is on the sort of what I would call the controllable side of things. And it's a more modest increase in taxes and insurance. But all the activity kind of base costs and payroll really are coming up pretty materially on a year-over-year basis.

All right. Thank you, Sean. Yep.

We'll now take a question from Rich Hill with Morgan Stanley.

Hey, guys. Good afternoon. I want to spend maybe a little bit more time talking about your suburban versus urban portfolio. We're right there with you on the urban portfolio and the inflections that we're seeing, and we think they're very real. But as you think about the urban portfolio, you and your peers have noted that rents are above, in many cases, pre-COVID levels. How are we supposed to think about those suburban markets going forward? Is there any chance that they begin to normalize while urban markets are inflecting? Or do you think that there's more than sufficient demand coming from a younger generation that can support that?

Yeah, Rich, Sean, I'm happy to start. Anyone else can jump in. I think you said that rents in our urban portfolio are above the pre-COVID peak. That's actually not the case right now.

I may have missed that.

Yeah, asking rents in the urban portfolio. Yeah, no worries. Asking rents in the urban portfolio down about 8% from the pre-COVID peak. But in the suburban portfolio, we're up, you know, a little more than 2%. And, you know, I tell you, you know, certainly we'll see a snapback, and we've already started to see that in the urban submarkets. But, you know, the suburbs are pretty healthy. I mean, if you keep in mind the slide that Ben showed, there's still a number of these sort of job-centered suburban submarkets that have probably another leg to come because people have not been called back to the office. If you think of just sort of maybe even the kind of the headline, you know, FANG stocks as an example, you know, people have not been called back to, you know, Google and Facebook and Apple and Amazon and Microsoft and Redmond. So there's some pretty good embedded demand that should be coming back to those environments that should support the suburban portfolio. And then additionally, Also, as Ben pointed out, if you look at sort of the single-family side, you know, it's a very tight market. Prices, if you look at kind of home price inflation on a year-over-year basis, it's kind of double digits. So the ability to exit into that product is more constrained. It's just not as available. So I think there's a number of factors when you look at the suburban portfolio that give it a fairly nice tailwind. You may not see the same sort of percentage gain over the next couple quarters as people come back to these urban environments just because it's so concentrated. But there's still some very good sort of demand tailwinds for the suburban portfolio over the next couple quarters as well. So, Tim, do you want to add on to that?

Yeah, Richard, I think another aspect to your question is just the notion that we would expect as the economy reopens and these urban markets reopen, we're going to just see convergence in performance. So there's going to be some normalization. I think Sean's right. It doesn't mean we're going to see suburban rents fall while urban rents rise, because there's still some pretty compelling supply-demand dynamics going on in the suburbs. But as I mentioned on the last call, I do think as you sort of think out, you look out over the next few years, supply, I think, in the urban markets is likely to be quite a bit lower than what we see in the suburbs. And And in some ways, you may see the relationship between urban and suburban flip this coming cycle relative to what we saw in the last cycle where urban demand was stronger, but urban supply more than offset that. So the suburbs actually outperformed. You get out three or four years from now, as I think I mentioned this in the last call, 2024-25, I would not be surprised if you see urban more than urban outperforming urban. the suburban markets. When you look long-term at our markets, it's one of the reasons why we've been somewhat agnostic and we want to have a diversified portfolio. Really, the winners and losers are really kind of at the MSA level, and the performance tends to normalize over time between the urban and suburban markets. It's a dynamic market, both on the demand and the supply side. But I think we are in a moment in time, obviously, right now, where urban is massively underperforming suburban. But we think we're kind of on the precipice where, you know, those lines are going to start to converge.

Yeah, Tim, thank you for that. And the reason I focus on it is, you know, I look at your weekly asking rent chart that looks like we're, you know, back to pretty close to back to pre-COVID levels. But it just strikes me, given this dynamic that you're talking about, you know, if you're looking at that one singular chart and suburban is above COVID and we're inflecting on urban, isn't there a really good chance that asking rents could completely overshoot on a weighted average basis as this recovery, you know, continues?

No, absolutely. You think about, you know, the reopening combined with the amount of fiscal and monetary stimulus, you know, being injected in the economy, I think we could see a really much closer to a V-shaped recovery than I think any of us were thinking about, you know, three, six months ago. I think maybe inside of a K-shaped recovery, because it's going to be an uneven, I think it's likely to be an uneven recovery, still favoring the educated and knowledge-based jobs. But, you know, that one slide that Ben showed that actually broke down the portfolio into the four buckets, you know, it's pretty telling, right? I mean, you had the other suburban at, you know, 6% asking rent growth, and, you know, the job center suburban, you know, a little over, down about 3%, secondary urban, down 6%, and core urban down 8%. Those are pretty big disparities from just a year ago, right? Yeah, as the economy opens, we would just expect things to start leveling off a bit.

Thank you, guys. That's very helpful from my perspective. Great.

Our next question will come from John Kim with CMO Capital Markets.

Thank you. Good afternoon. You've been a very consistent seller of assets at attractive returns and economic gains over the last, you know, throughout your history. But right now with cap rates compressing and 1031 on the table for potentially being repealed, do you think about expediting sales at all?

So, John, the question is because 1031 may come off the table.

I mean, it's, we've, We've used 1031s, but we haven't had to use them extensively. We typically have a couple hundred million, two, three hundred million as a sort of gains capacity and a typical year that we can absorb on the sales side. So it's really a function of how much portfolio recycling we really need to do. We've been pretty aggressive about it over the last few years. And if You know, we've used the 1031s on a limited basis to help kind of manage the tax impacts. But, you know, for the most part, we basically have just absorbed the gains capacity that we have embedded in our earnings.

So it's not just the 1031, but just the cap rates compressing so much. And is this a better time today to sell assets that are maybe a little bit older in your portfolio than it would be in the last few years?

Yeah, no, I think that's a fair point. You know, it's not that we debate. When we look at asset sales, we look at equity, we look at debt. Debt is still the most compelling source of capital today for us. But, you know, asset sales are creeping closer, for sure, just in terms of what we're seeing, you know, additional compression in cap rates and asset values. And a lot of the submarkets, particularly the suburban submarkets, are actually up from pre-COVID levels. So it's a Yeah, it's a fair point. It does inform some of our capital allocation decisions at the margin, for sure.

Okay. And then you've had noticeably stronger rental growth in April in southeast Florida and Denver. Do you see that outperformance continuing for the rest of the year? And also, how important is it for you to either expedite your exposure in those markets or potentially enter new markets, given this validated your strategy to enter them?

Yeah, John, this is Sean.

Why don't I take the first one, and then I'll let Tim talk about sort of the expansion market strategy a bit. But just the first one, one thing to recognize is that at present, those two expansion markets represent a very small basket of assets. So, you know, noise from one asset to another can create some volatility here. So the kind of growth that we've seen on a year-over-year basis in Q1, I would not expect that to be the same level moving forward for the balance of the year. There's just some unique factors with one or two of those assets, and when you only have three or four in the basket, it can move the needle quite a bit within one quarter. So I wouldn't count on that as sort of the run rate for the balance of the year.

John, this is Matt. I guess to the second question about kind of what our appetite is, I mean, we said we are looking to grow both of those markets to be roughly at least 5% of our portfolio, and so I think right now, including non-same-store, they're probably about 2% each, so we still have a ways to go. We do have starts planned in both of those regions in the next quarter or two, so we are continuing to move forward with development there. We have additional pipeline starts that are probably 22 starts in each of those regions, and we're out looking for more, and we're actively pursuing acquisitions in both of those markets as well, and We'll continue to do what we've done in the past, which is we find acquisitions, rotate capital out of some of our legacy markets to fund that. As it relates to other markets beyond those, I think we've said before that we are looking at other markets. We don't have anything to announce at this time, but we are looking for markets that are going to be over-indexed to the knowledge economy and over-indexed to the higher income jobs, the higher education jobs, which we think will drive outsized performance for our portfolio. And, you know, we do think Denver and Florida are two of those markets. And, you know, there are others as well that probably fit that description over time.

Great. Thank you.

Our next question will be from Rich Anderson with SMBC.

Hey, thanks. Good afternoon. So I heard, you know, you're sort of adjusting maybe at the margin some of the product that you're planning to deliver. You mentioned townhomes and direct entry-type product. And I'm curious, you know, if a hybrid office environment is sort of the first landing point for the office business, is that actually a good thing for multifamily, and your property in particular, because they need to be close to the office, but they're also going to spend more time at home, so, you know, more attention spent on having, you know, usable space where they live, too. Do you kind of see hybrid offices... a good thing for your business?

Rich, you know, I think, as I mentioned before, kind of agnostic between urban and suburban, and we're generally looking at where we think there's, you know, we're going to tilt towards where we think there's better value, and, you know, I think it argues that suburban household formation should be a little stronger this cycle than last cycle, as people don't have to commute as many days, and It just ought to spread the workforce out within an MSA and maybe across broader geography as well as people. There will be some folks who are going to be able to telecommute 100% of the time. But for those that are more in a hybrid situation, absolutely, we think there's going to be some people at the margin that are going to be willing to live 10, 15 miles further out than they otherwise would because they only have to be in the office two or three days a week versus five days a week. And we're in a position to capture them in either case.

Right, right. And the second question is, any other sort of post-pandemic changes that you're seeing in terms of how the business, the cadence of the business? Is there any silver lining, such as perhaps more likelihood to live alone, that kind of thing? Are you seeing anything like that, or is it just too soon to tell at this point?

Yeah, Richard, Sean, I'd say it's probably a little too early to tell. I think when we get up to the sort of other side of the pandemic and things stabilize, we'll have a better sense of, you know, has the resident profile really changed in terms of suburban or urban assets? And as we continue to communicate with our residents, maybe kind of touching on the last question that you had, that may inform our product choices in some of those suburban markets in terms of some of the larger floor plans. Will we provide in a way a workspace or work lounges in the building and program than more townhomes in some cases or things like that. It's probably just a little too early to peg that just yet.

Okay, great. That's all I have. Thanks.

We'll now take a question from John Pawlowski with Green Street.

Hey, thanks a lot. Matt, I'm curious if you can give us some sense of the compression and development yield, not on projects you're about to start, but If these construction cost pressures prove more persistent a year from now, what kind of development yield compression will we be looking at?

I wish I knew, John. I do think that cost pressures are definitely rising. But on the other hand, there's also the numerator, right? And we're underwriting deals still with rents that are, for the most part, Phil Kleisler- Less than maybe they were in the prior peak, you know, because a lot of our suburban development is is job center suburban Phil Kleisler- You know, maybe in some of the other suburban you know category from Ben slide. Maybe some of that rents are higher than the prior peak in terms of what we're underwriting. So I do think there's still some list to come on the numerator. Phil Kleisler- And I guess what I would say is on the denominator. What we've seen so far, you know, the deals that we're lining up now. In many cases, our total capital cost for those deals isn't any higher than it was a year ago. Maybe it's higher than it was six months ago as lumber's come up some, but, you know, there were some other trades costs which came down a little bit. Soft costs may have softened a bit. So, you know, certainly there's going to be some cost pressures going forward, and, you know, we're mindful of that. If anything, the margin right now is wider than it was on deals we started a year or two ago just because of what's happened to asset values and cap rates on the other side. So there's probably a little bit of room there.

Yeah, John, I guess I'd say I think the market, if I had a guess, would be betting on NOIs outpacing total development costs over the next 12 months. There's clearly some inflation pressures because of supply chain issues, I think as your question implies, and the real question is how transitory versus sort of permanent inflation you know, those cost pressures will be. But there's some pretty good pressures, there's some pretty good pressures building on the rent side, too. And so I think that's, I know you all have written a lot about the supply, you know, the supply side and sort of staying sort of stubbornly in that $350,000 to $400,000 range. I expect it's going to continue because I think as people are looking at economics and the people that do trend, you know, things are probably looking better today than they were, you know, maybe even a year ago.

Okay. That makes sense. Understood. Last one for me, Sean. In markets where you've had to pull the concession lever harder, as we anniversary that vintage releases sign with concession, do you expect occupancy to decline in the next few months due to just lower retention?

Yeah, no, good question, John.

I mean, I think it speaks to sort of the I guess you want to call it sort of the durability of the customers that have allowed us to build occupancy. I mean, we'll see. I mean, if you look at sort of portfolio income levels for our residents, they're down about 6% on a year-over-year basis. So, you know, based on what we've seen, I'd say there's some embedded capacity there to pay. Whether people want to pay or not will be a question that we'll have to come across here. I mean, in Q1, you know, we started to see pretty good lift. Turnover was up, but not for really financial reasons, just for other reasons in terms of people wanting to move for, you know, whether it's roommate situations or all the other sort of typical stuff. So it doesn't seem to be based on what we're realizing from our customers today, much in the way of financial pressure as we move through the second and third quarter, particularly in the urban environments, we'll have a much better sense for that. So could there be a little bit of pressure there? Yes. I mean, the other thing that I think we're going to see is right now, you know, Tim talked about the bad debt and kind of lapping the bad debt side of it. At some point, as we get it on the other side of the eviction moratoria, some of that bad debt is going to convert to just physical vacancy. So you can see a little bit of that start to trickle in in the back half of the year, just depending on what happens in the overall regulatory environment. So maybe a little noisy in terms of physical occupancy as it relates to that one issue alone in a couple of markets, particularly a place like L.A.

is an example. Okay. Thanks for your time.

We'll now take a question from Austin Werschmitt with KeyBank.

Thank you and good afternoon. Just a question on development, given the positive outlook that you have in your markets and some of the benefits you spoke to from the stimulus entering the system. How are you guys thinking about just sizing up the development pipeline overall in the next couple of years?

Yeah, I can start, and maybe Ben or Matt wants to jump in.

As Ben had mentioned, we are kind of upping our outlook here to over a billion this year. And as we talked about 30 years past, the middle of last cycle, The development pipeline was probably, you know, probably about a billion, four billion, five in terms of kind of how it was scaled. And we kind of rescaled as we got in the later part of the cycle and then downturned to, you know, something that was more in the, you know, 800 to 900 billion range. We think we can flex that up pretty, you know, pretty easily to a billion two without, you know, without too much trouble and probably to a billion and a half. So I think those are the kind of ranges we're looking at right now, absent potentially entering some new markets and expanding the footprint.

Got it. And then as far as some of the initiatives you guys outlined, the $10 million from some of the things you've already deployed on the technology side, and then you outlined another $25 to $30 million. What's the total investment that goes into generating that incremental NOI?

Yeah, awesome. Good question. So the way I lay it out for you is that the technology initiatives around the digital platform, the AI that Ben described, and things like that, that'll be roughly around $30 million. And then beyond that, the smart access and smart home component is the piece that's up in the air as a little bit of a TBD. based on customer adoption, what they're willing to pay, what features they want. Is it just the smart access component for guests, or is it more along the lines of thermostat control, lighting, you know, various other things. So that's a little bit of a TBD on the investment. But the foundational elements to have the infrastructure, the digital platforms, and all that's around $30 million. Great.

Thank you. Yep.

Our next question will be from Brad Heffern with RBC Capital Markets.

Hey, everyone. Just circling back to the development question, I'm curious, you know, last cycle and typically at the beginning of the cycle, you've seen a big trough in supply, and that's part of the reason that you ramped development at the beginning of the cycle. Certainly, we haven't seen as much of that this time around, so I'm curious, does that moderate your expectations as to how big the program could go?

you know versus how large it got in kind of 2013 14 15 that time frame yeah it's uh it became awfully profitable right you know last cycle particularly for the first three years it's uh we're we're developing a value creation margins that we hadn't seen really before probably in the 40 45 range in some cases so i you know i i think the range i talked about is is right you know kind of the billion to billion and a half it's probably a little less as it relates to enterprise value, maybe what you're driving at. I think it's about a billion, billion and a half seems about right just in terms of the opportunity set within our markets and kind of where the platform is scaled and what the balance sheet can kind of handle without sort of over-relying on the equity markets being continuously open.

Okay, got it. And then you touched on bad debt a little bit, but I was just curious, you know, it's hung out in the 3% range for several quarters now. Has there been any movement on that in April? And have you seen any impact from the federal funds at this point?

Yeah, Brad, this is Sean.

Happy to chat about that. And then Kevin can jump in if you'd like. But yeah, I mean, I think for us, we're not expecting a meaningful shift and bad debt until we get beyond kind of the moratorium that's in place today, which is likely in the second half of the year. There's a number of orders that are right now set to expire in June, I think June 30th. Some may be extended, some may not. It's a little too early to tell. So we're not seeing a lot of movement right now, sort of month to month, in terms of a significant shift one way or another. in bad debt. I suspect as customers see the light at the end of the tunnel in terms of, you know, the eviction option becoming available to us, we're going to see some greater movement. And then on the stimulus side, yeah, we're heavily involved in that. In some places we can apply sort of in bulk on behalf of our customers. In other locations we prompt them with emails where they have to sign up. And then we ultimately received the funds. So we received some funds, but I would tell you that it's been very slow and it's been sort of trickling as opposed to big avalanche of funds. But I just don't think the agencies that are within the states and counties set up to administer the funds, they just weren't set up for that. And therefore, it's taken quite a bit of time for them to figure out how to develop a process to make it work, get resident certifications, how do I get the funds to the landlord, the right owner, all that kind of stuff.

It's just been painfully slow. Okay, thank you.

Well, now I'll take a question from Alexander Goldfarb with Piper Sandler.

Hey, good afternoon. Just going back to the development, you know, I saw that you guys, the yields on the stuff that you have in the pipeline now are only 20, you know, 20 basis points lower. But just help me walk through, I mean, two by fours, lumber, I mean, anything mechanical, you know, anything involving construction is just through the roof. I mean, double-digit increases, substantial increases. Rents haven't kept pace. I understand the wider margin given cap rate depression, but just help me understand why development yields really seem unaffected given that, you know, rents are softer, construction costs are through the roof, Labor is still a challenge. What's the offset? Just help me understand.

Hey, Alex, it's Matt. So on the stuff that's currently underway, you know, that's all bought out. So, you know, that... No, that part I get.

That part I get.

In some cases, there are actually savings there, you know, because there was some sense that, you know, there was pretty strong momentum in construction cost inflation in many of our markets pre-pandemic. So, you know, a lot of it has to do with what Tim was saying, is it going to be kind of transitory based on supply chain bottlenecks or not? But I think there's a little bit of an underappreciation about how our cost breakdown actually works. I mean, if you think of a typical development deal and you say, for every dollar that's in a total development budget, 15 to 20 cents is land. So that, you know, and everything that's in our pipeline, you know, for the most part is land that we contracted, you know, before the pandemic. In some cases, you know, there was an opportunity to recut some of those land deals in some situations based on the slowdown we saw last year. Then you probably have anywhere from, you know, 15 to 20 cents that is soft costs, whether that's architectural engineering fees, permits, capitalized interest, which has come down. So there's a little bit of an offset there. And then, you know, then you have maybe, 60 to 65 cents that's the actual hard cost. And then when you drill down on that piece, you know, probably two-thirds of that is labor and one-third of that is materials. And actually even on the materials, when you peel it back further, a lot of those materials, it's not an appliance that you're buying. It's a roof truss, which is lumber, but it's also labor to put the roof truss together. So probably the key is, you know, is the pressure on labor costs. That's what would really move the equation more. I mean, we can see lumber's doubled, and it probably increases the total capital budget of a job by 3%, for example, 2% or 3%, which is something. But probably that's the thing I would keep an eye on would be labor costs, because if that starts to really move, that would start to, you know... Yeah, and Alex, I'm just trying to say that real quick.

I think in reality... Yeah, we underwrite on a current basis, as Matt mentioned before, current costs, current rents, current op-ex. Like in reality, the yields have deteriorated a little bit. So the deals that Matt talked about, we're going to start in the high fives. When we first put those in a contract and went through due diligence, they're probably low sixes in reality. So if you think about over the last two years, you know, rents, maybe they're flattish overall, particularly in these suburban markets, given that's where the focus is. the development pipeline is, and costs are up, the denominator is up a little bit. And so I think you probably have seen some deterioration of, I don't know, I don't know, somewhere between 25 and 50 basis points of yield erosion. But you've seen cap rate compression that's, you know, more or less offset that.

Okay, that's helpful. And then the second question is, as you guys think about the new markets that you want to enter, there's obviously a cost and efficiency, you know, critical mass, get a platform. How do you guys weigh straight-up acquisitions? I'm not saying that you guys go out and sort of bulk purchase a bunch of communities, but how do you weigh pushing on just buying some existing deals, even if the yields are a little skinnier than you'd want, versus using your development partnership with local landowners to get better yields, but understanding that it's going to take a longer time to establish that critical mass as you enter new markets? How do you balance those two?

Alex, this is Matt.

I mean, basically what we've been taking the approach is all of the above. So, you know, we're looking to buy existing assets. What we found in the expansion market so far has been it's been an opportunity to buy, in general, brand new or very young assets and not necessarily pay a premium on a cap rate basis versus older assets. So, you know, that's where we've tended to buy so far just because of relative value. Yeah, but ultimately we'd like to own some, you know, older communities in those regions as well just for price point diversification. So we're looking to buy, we're looking to build, and we're also looking to capitalize third-party developers, which we've done successfully. In fact, the deal we just completed last quarter in Doral in the Miami area was a partnership with a local merchant builder there where we funded it and we worked together on the deal. So that's kind of an expansion of our model a bit that we've that we're leaning on in these expansion markets. So that gives us another way we can get capital into these markets and grow our portfolio more quickly. So I don't think we view it as an either or. We view it as an all of the above.

Yeah, that was the only other thing I would add to that. It also gives us an opportunity to allocate capital over a period of time because they're not all on the same time horizon, right? So you buy assets today. If you're funding a third-party developer, that may be capital that goes out over the next one to three years. If you're developing for your own account where you're having to go through the entire process yourself, that's maybe more of a three to five year time horizon. So it allows us to diversify across time as well as sort of by product in a market.

Okay, thank you.

And we'll now take our next question from Alua Osterbeck with Bank of America.

Hi, everyone. Thank you for taking the question. I'll just be really quick. I want to ask a little bit more about Park Loja. So it seems like you guys had some good traction on the commercial leasing this quarter. Can you tell us who the tenants are and what box sizes are left that you guys have to lease? And then I think a while ago, you guys mentioned that it would be about 10 million in NOI annually once it's stabilized. Are you still on track for that?

Sure, this is Matt. Just to give you an update on the retail, as we mentioned in the earnings release, we did lease the remainder of the second floor space last quarter. So we're now about 87% leased on the retail. It leaves about 8,500 square feet remaining on the ground floor with Broadway Furnish. And our sense is for that remaining space, we're going to be patient to wait for a kind of activity to restart. in New York, which, you know, hopefully we'll start to see pick up in a more meaningful way in the next couple quarters. That is, you know, high dollar space, but the second floor space that we leased was leased to a medical user. So on the second floor, we have them. We have Fidelity, which is open and operating with a financial services office. And on the ground floor, we have Spectrum for a small portion of the ground floor. We have Target with their entrance, and then they have the low-grade space there. And then we have, you know, kind of the remaining available space on the ground floor. So, you know, we'll see where it settles out in terms of long-term, does it generate the amount of NOI that we talked about before? You know, obviously, street retail in New York is softer than it was, but a lot of it's going to depend on what we wind up getting for that remaining ground floor space.

Okay. Got it. Thank you.

And as a final reminder, that is star one if you would like to ask a question. We'll now take a question from Brent Dilt with UBS.

Hey, thanks. Given the return to office is expected to extend through the fall, how do you think that might impact the usual seasonal leasing trends as this year plays out?

Hey, Brent, Shawn. Good question.

Not sure we know the answer just yet in terms of how it's going to play out. Other than I would say, based on the data that we're seeing from prospects and new leases, in certain markets, we're seeing some people come back to some of these urban environments from more distant locations than normal. So like in New York City in the past quarter, when you looked at the distribution of the leases that we signed and where they came from, more people from locations that are, let's just say, greater than 50 miles away. So we're starting to see some percentage come back. You know, how it plays out is hard to tell. Obviously, as companies further announce what's happening with their return to office dates and the trend for universities in terms of on-campus learning in the fall has been pretty positive so far, I think, for our business, where most universities are planning for full on-campus learning, which should be a benefit to these major urban markets for their universities. And even if we, you know, as Ben pointed out, office occupancy is less than 20%. So it doesn't take a lot to start to move the needle. Even if we get to 50, 60, 70% of what it was previously, that's a pretty good movement from where we are today. So I think it's going to be a pretty positive trend between now and Labor Day. It's hard to say exactly how it's going to play out in terms of getting back to what we would think of as sort of pre-pandemic normal levels. And we really want to know that until we get past Labor Day.

Yeah, makes sense. Okay. And then just one other. On new leases in urban markets, what trends are you seeing in terms of demand by unit type or price point?

Yeah, the only thing I'd say is in the urban pockets that we're still seeing some difficulty with studio units in terms of single households. So if you look at overall occupancy, they're trailing the portfolio average a couple hundred basis points. It's most acute in the places you would expect, New York City, D.C., San Francisco, urban Boston, places like that. That's really the difference we're seeing in terms of sort of bedroom type at this point in time.

There's just not as much demand for the single houses yet. OK. Thanks, guys.

We'll now move to Dennis McGill with Zalman Associates.

Hi, Efton. Thank you. First question just goes back to the margin.

of potential from some of the technology investments. How should we think about the baseline for that 200 base point improvement? If we look pre-COVID, kind of in the 71, 72% range, that sort of more peakish cycle, how would you think about maybe a normalized margin and then what this savings would do on top of that?

Yeah, no, good question, Dennis. And what we look at is kind of our stabilized base years, what we call it. And so for the most part, it's kind of a blend. 2019 is kind of a proxy for controllable NOI margins, excluding taxes and insurance. That's how we think of where the base year is. And then moving from there, obviously things have distorted during the pandemic, given what's happened, but that'd be kind of the way we're looking at it, at least.

So essentially just controlling for property taxes versus pre-COVID?

Property taxes and insurance, yeah, which pushes those margins

If you look at it carefully and go back there, for example, like 18, 19, those same store margins, including that where they're kind of in the 80% range, 80% plus. You can map out each one in terms of what you've got out there in terms of 18 and 19. But 19 is really kind of a base year. Okay.

That's helpful.

And then this is probably tougher, but just wondering how you think about it with the – economy is reopening in some of these urban environments in particular, and you have a lot of young adults that are moving back in or back home or doubled up in some fashion, there's probably a pent-up demand element that the markets are experiencing right now. How do you get comfort around what that next leg of demand might look like, whether there's a continuation of pent-up demand or whether there's going to be an air pocket at some point once you get through sort of satisfying that first level of pent-up demand?

Yeah, good question. I'm not sure exactly how to answer the air pocket question.

I mean, we certainly expect people that left these urban environments to come back, not 100%, but people come back. What percent is sort of pure speculation? It would be hard for us or anyone else to say what that number is. In terms of the air pocket beyond that, it really just is a function of sort of the macroeconomy and what's happening with jobs and income growth and sort of more of the normal factors. that drive the business in terms of demand characteristics. On the supply side, we talked about that a little bit. We expect that to be relatively constant. Probably have a little bit of a tailwind from the single family market, as Ben pointed out, just given affordability issues in our legacy markets. So I think really I would just sort of pause and look at it as what's the macro environment look like from a demand supply standpoint? How does that support the business going forward once we get to the other side of the pandemic?

I appreciate the thoughts. Thank you, guys. Good luck.

And it appears there are no further telephone questions. I'd like to turn the conference back over to Mr. Naughton for any additional or closing remarks.

Great. Thank you, Anna. Thanks, everyone, for being on the call today. I know it's a busy day and a busy week. Catch up with you in early June, at least virtually, I think in A-Rate. So enjoy the rest of your day. Thanks.